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Nonlinear household earnings dynamics, self-insurance, and welfare

Author

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  • Mariacristina De Nardi

    (University College London (UCL)
    Federal Reserve Bank of Chicago
    Institute for Fiscal Studies (IFS)
    Centre for Economic Policy Research (CEPR))

  • Giulio Fella

    (Queen Mary University of London
    Centre for Macroeconomics (CFM)
    Institute for Fiscal Studies)

  • Gonzalo Paz-Pardo

    (University College London (UCL))

Abstract

Earnings dynamics are much richer than typically assumed in macro models with heterogeneous agents. This holds for individual-pre-tax and household-post-tax earnings and across administrative (Social Security Administration) and survey (Panel Study of Income Dynamics) data. We study the implications of two processes for household, post-tax earnings in a standard life-cycle model: a canonical earnings process (that includes a persistent and a transitory shock) and a rich earnings dynamics process (that allows for age-dependence of moments, non-normality, and nonlinearity in previous earnings and age). Allowing for richer earnings dynamics implies a substantially better fit of the evolution of cross-sectional consumption inequality over the life cycle and of the individual-level degree of consumption insurance against persistent earnings shocks. Richer earnings dynamics also imply lower welfare costs of earnings risk, but, as the canonical earnings process, do not generate enough concentration at the upper tail of the wealth distribution.

Suggested Citation

  • Mariacristina De Nardi & Giulio Fella & Gonzalo Paz-Pardo, 2018. "Nonlinear household earnings dynamics, self-insurance, and welfare," Discussion Papers 1817, Centre for Macroeconomics (CFM).
  • Handle: RePEc:cfm:wpaper:1817
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    References listed on IDEAS

    as
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    1. Nonlinear household earnings dynamics, self-insurance, and welfare
      by Christian Zimmermann in NEP-DGE blog on 2018-07-31 13:51:19

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    Cited by:

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    2. Giulio Fella & Serafin Frache & Winfried Koeniger, 2020. "Buffer‐Stock Saving And Households' Response To Income Shocks," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 61(3), pages 1359-1382, August.
    3. Amengual, D.; Bueren, J.; Crego, J.A.;, 2017. "Endogenous Health Groups and Heterogeneous Dynamics of the Elderly," Health, Econometrics and Data Group (HEDG) Working Papers 17/18, HEDG, c/o Department of Economics, University of York.
    4. Peter Ganong & Damon Jones & Pascal Noel & Diana Farrell & Fiona Greig & Chris Wheat, 2020. "Wealth, Race, and Consumption Smoothing of Typical Income Shocks," Working Papers 2020-49, Becker Friedman Institute for Research In Economics.
    5. Giovanni Gallipoli & Brant Abbott, 2017. ""Permanent Income" Inequality," 2017 Meeting Papers 1033, Society for Economic Dynamics.
    6. Francesco Lancia & Alessia Russo & Tim Worrall, 2020. "Optimal Sustainable Intergenerational Insurance," Edinburgh School of Economics Discussion Paper Series 300, Edinburgh School of Economics, University of Edinburgh.
    7. De Nardi, Mariacristina & Fella, Giulio & Knoef, Marike & Paz-Pardo, Gonzalo & Van Ooijen, Raun, 2021. "Family and government insurance: Wage, earnings, and income risks in the Netherlands and the U.S," Journal of Public Economics, Elsevier, vol. 193(C).
    8. Theloudis, Alexandros, 2021. "Consumption inequality across heterogeneous families," European Economic Review, Elsevier, vol. 136(C).
    9. de Bresser, Jochem, 2019. "The Role of Heterogeneous Expectations in Life Cycle Models : Evaluating the Accuracy of Counterfactuals," Other publications TiSEM 25d04a47-1020-47eb-ba94-4, Tilburg University, School of Economics and Management.
    10. Giulio Fella & Giovanni Gallipoli & Jutong Pan, 2019. "Markov-Chain Approximations for Life-Cycle Models," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 34, pages 183-201, October.
    11. Ursula Mello & Tomas Rodriguez Martinez, 2020. "Trade-induced Local Labor Market Shocks and Asymmetrical Labor Income Risk," Working Papers 1230, Barcelona Graduate School of Economics.
    12. Gomes, Diego B.P. & Iachan, Felipe S. & Santos, Cezar, 2020. "Labor earnings dynamics in a developing economy with a large informal sector," Journal of Economic Dynamics and Control, Elsevier, vol. 113(C).
    13. Manuel Sanchez & Felix Wellschmied, 2020. "Modeling Life-Cycle Earnings Risk with Positive and Negative Shocks," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 37, pages 103-126, July.
    14. Jeppe Druedahl & Michael Graber & Thomas H. Jørgensen, 2021. "High Frequency Income Dynamics," CEBI working paper series 21-08, University of Copenhagen. Department of Economics. The Center for Economic Behavior and Inequality (CEBI).
    15. De Nardi, Mariacristina & Fella, Giulio & Paz-Pardo, Gonzalo, 2020. "Wage Risk and Government and Spousal Insurance," CEPR Discussion Papers 15608, C.E.P.R. Discussion Papers.
    16. Heejeong Kim, . "Education, Wage Dynamics, and Wealth Inequality," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    17. Alessandro Di Nola & Georgi Kocharkov & Almuth Scholl & Anna-Mariia Tkhir, 2021. "The Aggregate Consequences of Tax Evasion," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 40, pages 198-227, April.
    18. Juan Carlos Conesa & Bo Li & Qian Li, 2020. "Universal Basic Income and Progressive Consumption Taxes," Department of Economics Working Papers 20-01, Stony Brook University, Department of Economics.
    19. Seth Pruitt & Nicholas Turner, 2018. "The Nature of Household Labor Income Risk," Finance and Economics Discussion Series 2018-034, Board of Governors of the Federal Reserve System (U.S.).
    20. Dal Bianco, Chiara & Maura, Francesco, 2020. "Education and persistence of earnings shocks," Economics Letters, Elsevier, vol. 196(C).
    21. Atif Mian & Ludwig Straub & Amir Sufi, 2020. "The Saving Glut of the Rich and the Rise in Household Debt," CESifo Working Paper Series 8201, CESifo.
    22. Atif R. Mian & Ludwig Straub & Amir Sufi, 2020. "The Saving Glut of the Rich," NBER Working Papers 26941, National Bureau of Economic Research, Inc.
    23. Wataru Kureishi & Hannah Paule-Paludkiewicz & Hitoshi Tsujiyama & Midori Wakabayashi, 2021. "Time Preferences over the Life Cycle and Household Saving Puzzles," CESifo Working Paper Series 8935, CESifo.

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    More about this item

    Keywords

    Earnings risk; Savings; Consumption; Inequality; Life cycle;
    All these keywords.

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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